Monday the Market Went Mad

Monday the Market Went Mad

Monday the Market Went Mad

Oct. 31 1997 3:30 AM

Monday the Market Went Mad

Herds, Hong Kong hyperventilating--and a brief moment of clarity.

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The headline appeared on the Reuters wire late Tuesday night. "Stock plunge may dent Finnish growth."

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Great. Just when we thought we were out of the woods, the damn Finns come along and throw everything into turmoil again. And here we always thought they could take care of themselves.

Of course, given the fact that U.S. trade with Finland--indeed, with all of Scandinavia--amounts to something less than 0.5 percent of our annual gross domestic product, one would hope that U.S. fund managers will be able to handle this news without panicking. But then the events of the past week have not done much to inspire confidence in the rationality of the American stock market. Take Intel, for instance. When the market closed Monday, U.S. investors thought Intel's shares were worth $63 billion. When it closed Tuesday, they thought the very same shares were worth $72 billion. God only knows what the news from Finland will mean.

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A sia is, of course, a much bigger and much more important part of the world economy than is Finland. Currency and equity-market turmoil in Asia has had, and will continue to have, real effects on America's real economy. In other words, it would be a mistake to dismiss all U.S. investors' worries about the impact of the Hong Kong sell-off on U.S. companies as the fearful bleatings of people who, having read too many silly headlines about globalization, suddenly decided--since everyone else seemed to have decided, too--that the sky was falling. But it would not be a mistake to dismiss most of their concerns as precisely that.

There were solid reasons for the sharp decline in the value of equities in Hong Kong itself, most obviously the precipitous rise in interest rates and the precipitous drop in liquidity as the central bank fights to keep the HK dollar pegged to the U.S. dollar. Still, it's hard to see the drop in the U.S. stock market as much more than a classic--if short-lived--case of what economists call "herding." In a strange way, it seems clear that people were looking for an excuse to sell, not simply to lock in profits for the quarter but also because the bull market had lasted too long and had risen too high. The odd thing about this panic, after all, is how unhysterical the actual trading was. Except for the minutes immediately following the half-hour break Monday, buy and sell orders were easily matched up and there were no stories, as there were in 1987, of market specialists simply refusing to pick up their phones and trade. Everyone was racing for the exits, but they were doing so in an orderly fashion.

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The fact that investors in some way wanted the bubble to burst, if only for a little while, can be seen also in the sense of relief with which many on the Street spoke of Monday's drop. It was as if, with a thousand points gone from the Dow, investors could look at the market a little more clearly and decide what they really thought. Of course, that feeling of clarity disappeared almost immediately Tuesday, as everyone suddenly turned around and started racing for the entrances, but it must have been nice while it lasted.

Is it cavalier to dismiss this past week as a simple illustration that humans sometimes act like sheep? Not really. (But then I would say that, wouldn't I?) In the first place, it's hard to see how even a 600-point drop in the Dow would seriously affect the U.S. economy. Except for IPOs (first-time public stock offerings), most American companies raise capital internally. The stock market is, in that sense, almost purely a secondary market. And while it's never good for consumer confidence to have brokers jumping out of windows, short and steep drops in the valuation of equities have nothing to do with the production of real wealth. In the second place, and perhaps more importantly, Asia isn't important enough to the American economy to justify a sell-off like we saw Monday.

Now, that may seem like a dubious assertion, particularly given the constant rhetoric about the global economy with which we are deluged and Coca-Cola's persistent evocation of the 1.2 billion Chinese who drink only one Coke each today but will drink two Cokes each tomorrow. But consider this: U.S. GDP is now somewhere close to $8 trillion. Last year, U.S. exports to all of Asia were $191 billion, or around 6 percent of GDP. Over a third of all U.S. exports do go to Asia, and that market has been growing rapidly in recent years. But it's still only of minor importance to the U.S. economy as a whole. And in any case, it's not as if Asia has suddenly vanished from the map. While growth rates throughout Southeast Asia are going to slow, those economies are not in recession, which means they will still be buying, even if less than before. If anything, the combination of currency devaluation and slower growth in Asia should help the U.S. equity market by continuing to keep inflation low and assuaging the Fed's concerns about an overheating economy (however dubious those concerns might be).

Having said all that, the Asian market undoubtedly is more important, in economic terms, to large U.S. corporations than it is to your local dry cleaner, and in that sense the GDP-export comparison is deceptive. According to some analysts, a third of corporate profit growth in the last fiscal year came from exports. So the rhetoric of globalization is not simply rhetoric. And that's especially true for certain sectors of U.S. industry. As has been much (too much) remarked upon, U.S. semiconductor-parts companies do a lot of business with Asian semiconductor firms. If demand for computers dries up in Asia, those parts companies will find it difficult to replace the business. The same may also be true, on a smaller scale, of larger software and hardware companies like Microsoft and Intel. On the other hand, many of these companies have assembly plants in the region. And if you can pay your bills in devalued ringgit and get paid in U.S. dollars, you're generally going to be pretty happy.

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U.S. multinationals have been feeling the sting of the strong dollar for some time now, and the continued weakening of Asian currencies will continue to hurt their profit margins. But it seems telling that it was IBM, which has seen currency problems erode earnings for two years now, that led Tuesday's rally by announcing it was going to buy back $3.5 billion of its own shares after the company's stock dropped eight points on Monday. Share-buyback plans are sketchy as long-term business strategies, but IBM's assurance that its shares were undervalued suggests that it's not particularly worried about the ultimate impact of Hong Kong's woes. Of course, there is always the chance that the company's management has simply gone mad.

In issuing what amounted to a public vote of confidence in the market, IBM was actually continuing a venerable tradition of Establishment attempts to quell selling panics by intervening loudly and decisively. In October of 1907, as the stock market was melting down, J.P. Morgan went to New York banks and compelled them to dip into their reserves to offer loans that would allow stockholders to cover their margins and begin buying again. In the midst of the crisis, he sent an emissary to the floor of the Exchange, where the man raised his hand, quieting the crowd, and said, "I am authorized to lend $10 million! There will be enough for everybody!" And that, at least according to the story, was that.

Twenty years later, it was J.P. Morgan and Co. again. At the start of the October 1929 market slide, when investors were dumping shares as fast as possible, Thomas Lamont of Morgan assembled a consortium of investment bankers who committed themselves to putting $20 million into the market. The Morgan representative came onto the floor of the Exchange, stepped into the middle of the caterwauling mob trading in U.S. Steel, and bid $205 for the company's shares at a time when the stock was already trailing well below that. Like the first, this was a rather cinematic moment, but it didn't work quite as well. Within three years U.S. Steel, like the market, lost 80 percent of its 1929 value.

I suppose it's a measure of how far we've come that IBM just issued a press release, though it would have been stirring to see CEO Lou Gerstner storm into the Exchange Tuesday to start buying up shares. In any case, IBM's decision was obviously not as momentous as either Morgan's or Lamont's, because they were dealing with genuine disasters while Big Blue was responding to a blip. Nor does Big Blue exercise the kind of financial or cultural power that Morgan once did. But the announcement was still a welcome slap in the face to a market that was hyperventilating for no good reason at all. Or, rather, to a market that was hyperventilating for as real a reason as there is: Markets are made up of people, and people sometimes get afraid. Even in Finland.